Dual Class Shares – Probably Worse Than Cancer

The Globe and Mail had an interesting article about a Canadian wealth management company called Guardian. Quick, click on that link before the Globe starts charging you. For those of you too drunk to work your mouse, let me summarize in a couple hundred words.

Guardian sold a big part of their mutual fund business to Bank of Montreal a while back. Because of this, they hold a whack of BMO shares. Like 5 million of them. That’s worth about $8.20 per share. The company also holds around $3 per share in cash and other securities. Guess what the share price is? $9.40. Meaning, you’re buying $11.20 worth of assets for $9.40, assuming the underlying wealth management business is worth nothing.

I’m pretty sure the wealth management business is worth more than nothing. Most wealth management companies get valued at 1-3% of the assets under the umbrella, since it shouldn’t be very hard to generate at least a 1% return on those assets with management fees. Once you crunch the numbers at just 1%, the wealth management business is worth a little over $8 per share.

If you add up the sum of the parts (and subtract the $1.75 per share of debt) you get a stock that’s either giving an investor the wealth management business or the BMO stake for free. Upon first glance, this looks like a classic value play. You take your position and wait for the market to figure out it’s undervalued.

Alas, if only things were that simple. (Also, alas. I sound so smrt.) The company does make money, sort of. Basically, the wealth management part of the company only breaks even, while all the profit comes from generous BMO dividends. BMO is currently yielding over 5%, paying $3.5M in dividends to Guardian every quarter, which go straight to the bottom line. Over the last year, Guardian’s quarterly profit averaged right around $4M.

There are a few things Guardian could do to unlock shareholder value. The wealth management business is obviously running as efficiently as a Soviet factory. Rumor has it Guardian’s fund managers take home very generous compensation packages. (I said rumor has it, don’t sue me Guardian.) If they could just take the steps to make their main business profitable, that could unlock all sorts of value.

The company could also increase the dividend substantially, once they pay off the debt anyway. Or, they could even sell the huge BMO stake and reward investors with a special dividend. After all, it makes little sense for a company like that to have such a massive position in one bank.

So what’s the problem? All shareholders need is somebody like Carl Ichan to show up, buy a bunch of shares, and put pressure on the company to take some shareholder friendly steps. The company will resist, but eventually will fold like Superman on laundry day. Kind of like the ladies when I relentlessly hit on them. They say yes just to shut me up. Pity dates FOR THE WIN.

Anyway, there’s only one problem with the activist shareholder plan. That problem is dual voting shares.

The voting shares and non-voting shares (which trade under the symbol GCG.A) both number about 34 million shares, except only one actually give shareholders a say in the company. The voting shares get 10 votes per share to 1 for the non-voting shares. The company is largely controlled by just a handful of investors, primarily one family who shall stay anonymous, mostly because I’m too lazy to look it up.

No matter what investors do to try to pressure the family into shareholder friendly moves, the family can block them. Unless you’re a hot chick who can convince the white old man (because it’s always a white old man) to do something, I don’t like your chances.

Up here in cold, cold Canada, these types of dual share structures are much more common than in the U.S. Some of our largest companies have dual share structures, like Magna, Telus, and CP Rail, just to name a few.

If the voting control is in the hands of just a few shareholders, regular shareholders have literally no say in a company’s direction. The controlling shareholders can stuff the board with friends. Usually upper management is tight with the controlling family, and management almost universally gets paid more than competing managers. You can yell as loudly as you want at the annual meeting, but it ain’t gonna change things. Non-voting shareholders are just along for the ride.

There’s another reason this is a problem – it creates confusion when shareholders are voting their shares. According to Computershare, a company that handles the proxy votes of shareholders for a couple thousand Canadian companies, over half of Canadian companies have problems with the accuracy of their shareholder votes. Most of the time, shareholder votes are mere formalities, but sometimes there are legitimate shareholder concerns that aren’t a slam dunk to pass.

Anyway, what’s the point? Should you run away from dual class voting companies faster than a redneck from a dentist? It depends on what kind of investor you are, really. If all you’re looking for is a blue chip company to maintain the status quo, there’s really nothing wrong with owning a company with dual class shares. Besides, it’s not like your 100 shares are going to make a lick of difference in the scheme of things.

If you’re buying companies like I do though, contrarian plays that are trading for less than book value, it presents more of a challenge. You either have to wait until the controlling shareholders’ priorities change, or try to pressure the controllers into change. I don’t like those odds. If you’re looking to buy a company like Guardian, you need an even larger margin of safety to make up for the headwinds of dual class shares.